Both chambers of Congress have passed tax reform plans that will invoke among the most significant changes to the tax code since the Tax Reform Act of 1986. Versions of the Tax Cut and Jobs Act passed by the House in November and the Senate in early December will be modified into a single bill following Congressional deliberations.
Enactment of the tax bill would cut taxes by more than $1.4 trillion over 10 years, as estimated by the Joint Committee on Taxation. Other projections also include a rise in the federal deficit, should economic growth not be sufficient to make up for the cost of the tax cuts. Passage of the tax reform bill may eventually lead to higher inflation because of possible growth in the federal deficit and an expanding economy. Economic expansion produces inflationary pressures that can increase wages and asset prices such as homes and stocks. In addition, tapering of fiscal stimulus in Europe by the European Central Bank (ECB) may also add to international inflationary pressures, which has been one of the ECB’s primary objectives.
Equity markets rose in November with the Dow Jones Industrial Index climbing past 24,000 and the S&P 500 Index eclipsing the 2600 level, as the likelihood of tax reform passage became more apparent. Companies with strong balance sheets have been out performing those with weak balance sheets, as the market prepares for possible tax ramifications of companies deducting certain interest expenses. Markets expect the Fed to raise short-term rates again in December as improvements in the economy and labor markets materialized further. The unemployment rate dropped to 4.1% in October, the most recent data available from the Labor Department, the lowest rate since December 2000. (Sources: Fed, Labor Dept., Dow Jones, S&P, Congress.gov/bill/115th-congress/house-bill/1)
Equity Update – Domestic Stock Markets
The Dow pierced through 24,000 towards the end of November as optimism about tax reform passage intensified. A primary emphasis to reduce both corporate tax rates and small business rates accelerated equity prices higher as optimism grew with the realization of passage.
The relationship between corporate taxes and equity valuations have been significant with the anticipation of a lower corporate rate, which has been elevating stocks ever since the election. The reduction in the corporate rate from 35% to 20% is expected to benefit certain companies more than others as tax rates vary among sectors.
Analysts view the recent decline in the technology sector as a form of market rotation, the exodus of assets from one market sector to another. The anticipation of various tax reform proposals may adversely affect technology companies while benefiting other industry sectors. The passage of tax reform might also prompt a further rotation to companies that may benefit from corporate tax proposals once in effect. (Sources: Dow Jones, S&P, Bloomberg)
What Taxpayers Own Stocks – Consumer Review
Tax reform has created questions about which taxpayers actually own stocks and benefit from certain tax provisions. Tax reform legislation has presented various proposals that would benefit long-term investors in the market. Repealing the estate tax would allow more families to transfer wealth accumulated in assets such as stocks to heirs without paying a tax. Corporate tax cuts and repatriated cash would benefit stock prices as companies would be enticed to buy back stock, increase dividends or invest in capital expansion.
Either way, the eventual benefits of these new tax rules are expected to benefit stockholders. Unfortunately, the bulk of households that own stock are in the upper income brackets, meaning that many don’t get to participate in any stock market increases resulting from tax reform. Federal Reserve data shows that 95% of families in the top 10% by income hold stocks directly and/or mutual funds that hold stocks, while lower income households tend to have much less. (Source: St. Louis Federal Reserve)
The Tax Cut and Jobs Act – Fiscal Policy Update
Senate and House Republicans each passed their own version of the Tax Cuts and Jobs Act, yet differ in various ways, setting arguments into motion. When the chambers pass different versions of a bill, conferees are appointed by both the House and the Senate to produce a “conference report” that is satisfactory to the majority of conferees from each chamber. The closer the two sides are going into conference, the easier the resulting process.
The focus of the Tax Cuts and Jobs Act is to lower taxes mainly for corporations and smaller businesses, and a portion of individual taxpayers. Targeted are wealthy individuals who live in high tax states that may lose valuable deductions. So the emphasis of tax reform this time around is on reducing corporate taxes, paid for by higher taxes on wealthier individuals due to a sustained top tax rate and loss of various deductions.
Some of the proposals where both the House and the Senate agree:
Retain the state and local tax property tax deduction, capped at $10,000; Expand 529 college savings accounts to apply to some primary and secondary education; 20 percent corporate rate, reduced from 35%.
Before the President can formally endorse the passage of the tax reform proposals, both the House and Senate will have to agree on one plan. The objective is to have the House and Senate hash out the details of both plans into a single piece of legislation and have it ready for signature by the President by the end of the year. (Sources: Tax Foundation, IRS, Congress.gov/bill/115th-congress/house-bill/1)
Market Returns: All data is indicative of total return which includes capital gain/loss and reinvested dividends for noted period. Index data sources; MSCI, DJ-UBSCI, WTI, IDC, S&P. The information provided is believed to be reliable, but its accuracy or completeness is not warranted. This material is not intended as an offer or solicitation for the purchase or sale of any stock, bond, mutual fund, or any other financial instrument. The views and strategies discussed herein may not be appropriate and/or suitable for all investors. This material is meant solely for informational purposes, and is not intended to suffice as any type of accounting, legal, tax, or estate planning advice. Any and all forecasts mentioned are for illustrative purposes only and should not be interpreted as investment recommendations. Securities offered through Triad Advisors, member FINRA/SIPC. Advisory services offered through Lee Johnson Capital Management, LLC (LJCM). LJCM is an independent Registered Investment Advisor and is not affiliated with Triad Advisors.